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Using ESG for valuation purposes

CBA’s Pensions and Benefits Law Section wants to encourage investment strategies that take into account climate change and the transition to a low carbon economy.

Green dollar signs

Environmental, Social, and Corporate Governance (ESG) are factors we use to measure the social impact of investments. ESG factors matter to pension funds for many reasons, including demonstrable interest in sustainable investing from plan participants. But what does it mean for plan administrators?

In January 2021 the Office of the Superintendent of Financial Institutions (OSFI) launched a consultation to get feedback on how federally regulated pension plans (FRPPs) can best manage climate-related risks. While OSFI recognizes the need for a larger discussion on ESG factors in the future, the January discussion paper focuses on climate-related risks. In its comments, the Pensions and Benefits Law Section of the Canadian Bar Association supports the incorporation of climate-related risk assessment in statements of investment policies and procedures, like the approach adopted under Ontario’s Pension Benefits Act.

However, given the urgency to address climate-related risks, the CBA Section recommends OSFI go beyond Ontario’s reporting requirements. “This approach would serve OSFI’s goal of encouraging FRPPs to adopt investment strategies that account for the risks and opportunities associated with climate change and the transition to a low carbon economy. In addition, it would help address what international observers call a lack of guidance and uniformity in the Canadian regulatory system for the integration of climate-related risks into pension fund investment strategies.”

The Section notes that Ontario requires plan administrations to disclose whether ESG factors are considered and if so, how. It recommends OFSI make ESG disclosure mandatory for all FRPPs and give more guidance and clearer definitions of ESG factors generally and on climate-change risks in particular. Specifically, bringing forward detailed definitions of environmental factors that specifically highlights the investment concerns of climate change and the transition to a low carbon economy. “In our view, adopting this approach federally would lead the way for implementation of similar requirements in other Canadian jurisdictions.”

The Section notes that addressing climate-related risks often entails dealing with what it calls “information uncertainty.” That’s why it takes pains to point out that plan administrators should be deemed to have fulfilled their fiduciary obligations if their investment decisions are made in good faith, in the interest of plan beneficiaries and considering climate concerns.

Proper consideration of ESG factors is not separate from regular investment decisions, the CBA Section says, and OSFI should make it clear that it is “a component of the valuation and assessment of future asset performance over the short, medium and long term. In particular, climate-change risk should be identified as financially material consideration for the purpose of disclosure on statements of investment policies and procedures.”

Preparing for and being resilient to climate-related risks are part and parcel of the fiduciary duties of plan administrators to the plan beneficiaries, the Section concludes. This key principle should guide OFSI in its work.